Now Or Never Tax Breaks
Take advantage of write-offs set to expire for kids, retirees and homeowners.
By Mary Beth Franklin, Senior Editor
From Kiplinger's Personal Finance magazine, December 2007
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Sure, you're busy drawing up holiday gift lists for family and friends. But don't forget to give yourself a present: a lower tax bill next spring.
Now's the time to make last-minute moves to trim your 2007 taxes. Beyond heeding the standard year-end advice of maxing out tax-deductible retirement savings, donating to your favorite charity and selling losing investments to offset taxable gains, you may benefit from taking advantage of several other tax breaks scheduled to expire this year.
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For instance, retirees 70½ and older get one last chance to avoid paying taxes on up to $100,000 in IRA distributions donated directly to a charity. Homeowners who install energy-efficient improvements by December 31 can claim a tax credit of up to $500. And consumers who deduct state sales tax on their federal return have until New Year's Eve to purchase big-ticket items, such as a car or boat, to add to their sales-tax tally.
But the trickiest year-end maneuver is reserved for parents looking to trim taxes on their investment earnings by giving assets to their children. If you're in that situation, act fast. Next year, an expanded "kiddie tax" -- which taxes a child's investment income above a certain level at the parent's higher rate -- will affect older offspring.
Dodge the kiddie tax
In 2007, the kiddie tax applies to children younger than 18 whose investment income exceeds $1,700 (the first $850 of a child's unearned income is tax-free, and the next $850 is taxed at the child's lower rate). Starting in 2008, children under 19 and full-time students under 24 will also be subject to the kiddie tax (children who provide more than half of their own support are not affected by the change). The first $900 of a child's unearned income will be tax-free, and the child's lower rate applies to the next $900.
What does this change mean to you? If you have children between the ages of 18 and 23, they aren't affected by the kiddie tax this year, but they will be in 2008. In 2007, they can still take advantage of the 5% rate on long-term capital gains that's available to taxpayers in the two lowest tax brackets, says Anne-Marie Fisher, director of tax services for CBIZ Accounting, in Chicago. Higher-income taxpayers pay a maximum capital-gains tax of 15% on qualified dividends and profits on investments held for one year or longer.
Megan Hakala, 19, falls into the kiddie-tax sweet spot. Earlier this year, Megan's parents, Jack and Maggie, gave the college sophomore shares of Marriott stock with a market value of $24,000 -- the maximum married couples can give to an individual without filing a federal gift-tax form. Jack had acquired the stock at a discount when he worked for Marriott, and when you transfer a stock or other property, the recipient of the gift assumes your original cost basis and holding period. Megan will sell the stock this year and use the cash to pay her tuition at Michigan State University.
The income-shifting strategy will save the Hakalas at least $1,600 in capital-gains taxes in 2007. That assumes $16,000 in profit from the sale and a ten-percentage-point spread between Megan's 5% capital-gains rate and her parents' 15% rate. "We certainly want to minimize our taxes," says Jack, a controller with Sodexho USA, near Detroit. "That's why we decided to go full speed ahead and take advantage of these tax breaks while we can."
The Hakalas also plan to transfer stock to their daughter Jillian, 16, who will be headed to college in two years. They'll have her sell just enough stock this year to keep her profit below $1,700 and hold the maximum tax to her 5% capital-gains rate. They also intend to fully fund a Michigan 529 college-savings plan -- an increasingly attractive vehicle given the latest change in the kiddie-tax rules. That will qualify them for a state-tax deduction of up to $10,000 for 2007.
Give to charity
This year,IRA owners who are 70½ or older can make direct, tax-free donations of up to $100,000 from their IRAs to qualified charitable organizations. The donation can satisfy the requirement that retirees take minimum distributions from their retirement accounts each year.
You can't claim a charitable deduction for your IRA contribution, but the tax break (which applies whether you itemize or not) may be even more valuable because you don't have to include the IRA distribution in your adjusted gross income. By lowering your AGI, you could benefit from other tax breaks, such as reducing taxes on your Social Security benefits or boosting your deductible medical expenses.
Note that this tax break applies only to IRAs, not workplace-based retirement accounts such as 401(k)s. And not all charities are eligible recipients. For example, you can't make tax-free IRA donations to donor-advised funds or use the money to fund charitable remainder trusts or charitable gift annuities.
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